A simple tutorial on what is purchasing power parity(PPP) and how it is calculated with the sample example problems.
The Purchasing power parity is one of the important metric for macroeconomic analysis. The purchasing power parity (PPP) is an economic theory which compares the two countries spending power against the basket of related goods. Generally purchasing power is determined by the cost of living and inflation rates in all different countries. The below tutorial explains on how to calculate purchasing power parity (PPP) ratio with the simple examples.
Purchasing Power Parity Formula
The formula for purchasing power parity(PPP) is given below which requires two prices in different currencies to estimate the price ratio.
Purchase Power Parity Ratio = Price 1 / Price 2
Purchasing Power Parity Example:
Lets research the prize of Big-mac in United states and Mexico
A Big mac costs $3 in U.S. dollars and 60Mexican pesos.
Step 2: Substitute the values in the formula,
Purchase Power Parity Ratio = 60/3
Compare the result of the purchasing power parity to the currency exchange rate between the United States and Mexico. It should be equal.